Will American Eagle’s Stock Soar Or Dive Due To Covid Recession?

American Eagle Outfitters stock (NYSE: AEO) has declined nearly 15% since the beginning of the year due to the outbreak of Covid-19. A Covid recession will impact the company’s revenues, cash flows, and ability to pay dividends. We estimate that a recession that persists through late Q3/early Q4 2020 can reduce the company’s revenues by 30% from $4.3 billion in 2019 to $3 billion in FY2020. American Eagle has taken a string of measures to preserve its profitability and cash reserves – including reducing capital expenditures, suspending/delaying payments of dividends, and temporarily furloughing its employees. We believe all these measures will help the company preserve its liquidity even if the situation worsens.

However, American Eagle has faced the brunt of the outbreak of coronavirus, with the company’s revenues plunging by nearly 38% in Q1 2020 (ending April). Fading consumer demand, rising unemployment levels, reduced discretionary spending, and stay-at-home orders resulting in store remaining closed continue to take their toll on the company’s business. Trefis analyzes the potential impact of Covid Recession on American Eagle in an interactive dashboard with a focus on the company’s liquidity reserves and concludes that American Eagle is in a strong financial position, and a Covid-19 recession will not impact the company’s cash reserves in FY2020. Although a downturn will impact the company’s revenues, cash flows, and ability to pay dividends, we believe the company has adequate financial reserves at its disposal to sail through this pandemic.

Impact On American Eagle’s Revenues 

• We estimate that a recession that persists through late Q3/early Q4 2020 can reduce the company’s revenues by 30% to $3 billion in FY2020.
• Although stores have started opening, store traffic is expected to remain well below pre-pandemic levels for several months, at least. Further, social distancing measures are likely to continue for a while, which will impact store capacity for the company.
• However, American Eagle has two of the most established brands in the retail business. Moreover, the company has a well-established digital channel, which grew 33% in Q1 2020 despite the pandemic, with demand for Aerie’s products swelling by more than 75%. The combined impact of American Eagle’s brand value and the digital channel will help to mitigate the impact on the company’s top-line.

Impact On American Eagle’s Cash Flows

• American Eagle’s cash flows are likely to take a hit in FY2020 due to a steep reduction in revenues and a potential hit to profitability.
• The company will have to offer merchandise at a deep discount to clear out the existing inventory, which will hurt the company’s bottom line.
• However, American Eagle has taken a number of measures to mitigate the impact on its cash balance by raising $330 million under its credit facility and issuing $400 million of senior convertible notes (debt).
• Also, the company has decided to substantially reduce expenses across all operating heads, including store occupancy costs, capital expenditures, and reduced inventory purchases while also suspending dividends and share repurchases.

Despite these measures to conserve cash, we estimate that Free cash flow from operations (excluding restructuring charges) (FCFO) will go down from $457 million in 2019 to around $170 million in 2020. Also, with expected capital expenditures of $113 million for the year, FCFO-CapEx will be just $56 million in FY2020.

Cash Balance Impact

• Taking all these factors together, we estimate that American Eagle will end the year with a cash balance of $1.2 billion – higher than the figure at the end of 2019 (please note that this figure will be lower if we account for restructuring charges)
• This figure includes $730 million in fresh capital the company recently raised.
• While the stringent measures taken by the company may dampen growth prospects in the near term, these moves by the company are essential for its long-term survival.

Conclusion

To sum things up, American Eagle has ample cash reserves and can successfully weather a recession through Q3/Q4 and a 30% decline in revenues by cutting Capex and share repurchases, and thanks to the $730 Million in fresh capital it raised recently. For an alternative scenario with a 20% change in revenue, see our full analysis of the impact of COVID recession on American Eagle

Our dashboard forecasting US COVID-19 cases with cross-country comparisons analyzes expected recovery time-frames and possible spread of the virus. Further, our dashboard -28% Coronavirus crash vs. 4 Historic crashes builds a complete macro picture. Additionally, the complete set of coronavirus impact and timing analyses is available here.

While American Eagle looks well-positioned, a recession could wipe off more than $1 billion from peer Gap’s cash reserves.

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